There are strong arguments for continued investment in microcredit. These arguments are based on, not in contradiction to, the recent evaluations of microcredit impact. That the average impact of access to microcredit is modest is not in serious doubt. However, every evaluation of the impact of microcredit shows that there are people who benefit, and that most borrowers, when lenders behave responsibly, do not experience harm. Comprehensive research on microfinance and subsidy shows that virtually all microfinance institutions are subsidized, but these subsidies are small. There are two clear paths for increasing microcredit’s impact through continued investment.

The Social Meaning of Money too shows how preferences develop and are reinforced by social contexts. Economists have not yet paid much attention to preference formation, but the work so far suggests that it is a promising path for empirical inquiry, especially as researchers look to next steps in understanding the economics of gender and the nature of decision-making under conditions of substantial scarcity.

The financial and business models for collecting savings by microfinance institutions have been relatively little explored in literature. This paper seeks to fill the gap by evaluating deposit-taking MFIs that rely on two primary types of savings: those that emphasize raising funding (through large deposit accounts) and those that emphasize service (through small deposit accounts). The findings suggest that geographic location, level of economic development, and regulatory environment all play an important role in dictating the types of models that are likely to be adopted. Different models also have substantially different funding and operating costs. Finally, net outreach levels in terms of number of savers served appear to be little affected by choice of model, though in many cases outreach may be skewed by widespread presence of empty accounts, which overstate the number of active depositors, and understate the average account balance.

For the world’s poor, living with unpredictable and inadequate income flows makes it difficult to cope with risk. Catastrophic events such as illness or crop failure can be devastating financially. Households use a variety of strategies to protect themselves from misfortune. Formal insurance may be the last resort after all other possible mechanisms for risk protection become unworkable.

But how exactly will insurance be delivered? What new innovations matter most in insuring the poor? What can be done to increase microinsurance take‐up rates? This briefing note seeks to explore these questions and provide additional resources on these and related topics.

It would appear self-evident that poor families are unable to save. If these households are barely making ends meet, they must be so preoccupied with covering immediate needs that thinking about the future is a luxury. However, this proves not to be the case. Most poor households, even those earning less than $2 a day per person, have disposable income (Banerjee and Duflo, 2007).1 And yet, demand for and use of formal and informal savings products falls far below what theory would predict.

In this briefing note, we explore the benefits and risks for saving, the issue of profitability for making savings products available to the poor, how people are saving, and new innovations that can facilitate great access to savings tools.

Digital payments may be an important part of closing gaps around financial access. But how will digital payment systems be deployed? What design elements would create value for poor users? How can payment systems be the first stepping stone to other financial products? What are the regulatory issues surrounding mobile payment systems? This briefing note seeks to explore these questions and provide additional resources on these and related topics.

We combine two datasets to examine whether the scale of an economy’s banking system affects the profitability and outreach of microfinance institutions. We find evidence that competition matters. Greater bank penetration in the overall economy is associated with microbanks pushing toward poorer markets, as reflected in smaller average loans sizes and greater outreach to women. The evidence is particularly strong for microbanks that rely on commercial-funding, use traditional bilateral lending contracts (rather than group lending methods favored by microfinance NGOs), and take deposits. We consider plausible alternative explanations for the correlations, including relationships that run through the nature of the regulatory environment and the structure of the banking environment, but we fail to find strong support for these alternative hypotheses.

The US Financial Diaries track the finances of a small sample of low and moderate-income households over a year. The households faced substantial swings in income from month to month. On average, they experienced 2.5 months when income fell more than 25 percent below average...

Budgeting can be a daunting task for the poor. Poor families must stretch low, often-volatile income to meet basic consumption needs, and handle un- foreseen expenses. Despite these challeng- es, the poor are able to save. They oftendo so in small amounts for short periods of time, adding to and spending down savings frequently. But short-term saving seldom results in long-term assets—it is not a tool for building up larger sums . . .

Savings groups are a popular and effective way of helping poor households increase their savings. But is there a way to incorporate the mechanisms that make them effective outside of the group in savings products in general?

Despite conventional wisdom, poor families DO save. However, they do not always have access to safe, reliable systems to build savings. Savings groups are one tool that help poor households better manage their financial lives.

Jonathan Morduch of the Financial Access Initiative, and Rachel Schneider of CFSI discuss the new report from the U.S. Financial Diaries Project. Households often use informal tools that are harder to see from outside, like short-term loans from friends or relatives.

What accounts for the determination of migrants to make it across borders, braving incredibly harrowing journeys by train, boat and foot? For many people around the world, migration is the very best investment they can make.

Timothy Ogden, managing director of NYU's Financial Access Initiative discusses the U.S. Financial Diaries project, which tracked the financial activity of over 200 lower-income American households for a full year.

FAI's Tim Ogden sat down with David McKenzie, Lead Economist in the Development Research Group at the World Bank to discuss the importance of mental accounting in his work and the development research agenda.

FAI's Tim Ogden sat down with David McKenzie, Lead Economist in the Development Research Group at the World Bank to discuss the importance of mental accounting in his work and the development research agenda.

FAI's Tim Ogden and Michael Clemens, Senior Fellow at the Center for Global Development (CGD) and visiting scholar at NYU-Wagner, recently published a Framing Note discussing new research approaches on the role of migration and remittances in household financial management.

FAI's Tim Ogden and Michael Clemens, Senior Fellow at the Center for Global Development (CGD) and visiting scholar at NYU-Wagner, recently published a Framing Note discussing new research approaches on the role of migration and remittances in household financial management.

FAI's Tim Ogden and Michael Clemens, Senior Fellow at the Center for Global Development (CGD) and visiting scholar at NYU-Wagner, recently published a Framing Note discussing new research approaches on the role of migration and remittances in household financial management.

"What do you do with the households that are so poor that there is no real sustainable livelihood going on?" Professor Dean Karlan and FAI's Managing Director Timothy Ogden discuss some of the recent research into poverty alleviation programs targeting the ultra-poor; questions of internal validity versus external validity; and evaluating economic well-being as well as psychological well-being.

It is time to fundamentally reframe the research agenda on remittances, payments, and development. We describe many of the research questions that now dominate the literature and why they lead us to uninformative answers. We propose reasons why these questions dominate, the most important of which is that researchers tend to view remittances as states do (as windfall income) rather than as families do (as returns on investment). Migration is, among other things, a strategy for fi- nancial management in poor households: location is an asset, migration an invest- ment. This shift of perspective leads to much more fruitful research questions that have been relatively neglected. We suggest 12 such questions.

FAI Managing Director Timothy Ogden and Harvard Business School Associate Professor Nava Ashraf continue their discussion of her commitment savings research. In Part 3 of the conversation, they talk about product design, behavioral psychology, and more.

FAI Managing Director Timothy Ogden and Harvard Business School Associate Professor Nava Ashraf discuss her commitment savings research. They also talk about what we currently know about commitment savings and why it works.

“Does microcredit work?” It’s a question we hear a lot. But the answer depends on what the question really is. Does microcredit slash poverty? (Not clearly.) Does microcredit increase micro-enterprise profit? (Some of the time, but capital often gets channeled to other uses and not everyone is a great entrepreneur.) Does microcredit improve the lives of borrowers? (Yes it can, but seldom dramatically and sometimes microcredit can get borrowers into trouble.) Rather than being a single tool used to solve a single problem (like funding a business), microcredit is often one among a set of tools, whose usefulness as a set may be fundamental but whose individual impact is often incremental and thinly spread.

Early pioneers of the microfinance movement touted it as a vehicle to promote entrepreneurship and subsequently provide a pathway for poverty alleviation. However, financial diaries research such as that published in Portfolios of the Poor, shows us that microloans have multiple purposes beyond spurring small‐scale enterprises. The poor have myriad expenses beyond their business endeavors such as health care costs, school fees, housing repairs, and unexpected emergencies. Consumer lending is one possible tool to help the poor cope with their (often unpredictable) consumption financing needs. However, it may not be the appropriate solution in all instances and also carries the risk of encouraging over‐ indebtedness and financing for “bad” consumption, such as to buy aspirational material goods.

The net impact of development interventions can depend on the availability of close substitutes to the intervention. We analyze a randomized trial of an innovative anti-poverty program in South India which provides “ultra-poor” households with inputs to create a new, sustainable livelihood. We find no statistically significant evidence of lasting net impact on consumption, income or asset accumulation. Instead, income from the new livelihood substituted for earnings from wage labor. A very similar intervention made a large difference elsewhere in South Asia, however, where wage labor alternatives were less compelling. The analysis highlights the roles of substitution bias and dropout bias in shaping evaluation results and delimiting external validity.

Economist Shawn Cole discusses findings from several experiments on rainfall insurance in India and index insurance products. In Part 2 of this FAI video conversation, Cole discusses an experiment that was conducted in Gujarat, India. Here the researchers were interested in understanding what were the barriers to adoption of a particular product. The goal of the study is to help farmers manage risks due to failed monsoons when making production decisions.

Shawn Cole discusses findings from several experiments on rainfall insurance in India and index insurance products. The goal of the effort is to help farmers manage risks due to failed monsoons when making production decisions.

We replicate and reanalyse the most influential study of microcredit impacts (Pitt and Khandker, 1998). That study was celebrated for showing that microcredit reduces poverty, a much hoped-for possibility (though one not confirmed by recent randomized controlled trials). We show that the original results on poverty reduction disappear after dropping outliers, or when using a robust linear estimator. Using a new program for estimation of mixed process maximum likelihood models, we show how assumptions critical for the original analysis, such as error normality, are contradicted by the data. We conclude that questions about impact cannot be answered in these data.

Ogden and Pande discuss her work and why standard microcredit may undermine business investment, from her recent paper: "Does the Classic Microfinance Model Discourage Entrepreneurship Among the Poor?"

About half of the world’s adults lack bank accounts. Most of these “unbanked” are deemed too expensive to serve, or not worth the hassle created by banking regulations. But what may be good business from a banker’s perspective isn’t necessarily what’s best for society. The inequalities that persist in financial access reinforce broader inequalities in the distribution of income and wealth. This is the opening for microfinance – and also its challenge.

Poor households in developing countries face large and varied risks, but often have inadequate informal tools to manage them. Microinsurance is being developed to create a better alternative, and it should--in theory--be in high demand. Yet take-up of microinsurance remains low. I study the impact of price and information on the demand for life microinsurance among microfinance borrowers of Compartamos in Mexico. I randomly assigned 8,700 borrowers to two of four treatments: (i) no longer receive a base amount of subsidized insurance coverage (high price) or keep the subsidy (low price), and (ii) being informed with a message emphasizing the financial toll of a funeral and how the insurance payoff helps to face it (financial information) or information emphasizing the emotional toll of a funeral on the surviving family (emotional information). On average, eliminating the subsidy led to a decrease in insurance coverage, but the two messages did not impact coverage. The impacts are heterogeneous, however. . .

A formal bank account provides a secure way to save, and is the gate- way to accessing many other financial services that can help individuals manage their financial lives. While a formal account is taken for granted as a necessity by many people in high income countries, account access varies widely for their low income counterparts.

Although there is an overall positive relationship between GDP per capita and rates of account holding among coun- tries in the sample, differences of twenty percentage points or more are not uncommon be- tween countries with similar income levels. For example, over 40% of residents of Kenya have a formal account while less than 10% of Benin’s residents do.

In 1990, Carlos Danel and Carlos Labarthe co-founded Compartamos—which means "let's share" in Spanish—to provide poor residents (mainly rural women) of Mexico with access to economic opportunities. At its inception Compartamos was a nonprofit organization serving mainly indigenous, rural women in some of the poorest regions in Mexico. The company has since evolved into a commercial bank. While some are critical of the company for what they believe is its emphasis on profits over social returns, our research into microfinance and social investment provides a more nuanced response to the criticism. Nonetheless, there's no denying Compartamos' impact on the region. It is currently one of the largest microcredit institutions in all of Latin America. Most of its more than 600,000 clients live in rural areas of Mexico.

High quality evidence on the state of financial access around the world is advancing rapidly, as the chapters of this book illustrate. A happy consequence of increasing knowledge is the ability to better recognize what we don’t yet know. Here are ten questions, some micro, some macro, that need answers if we are to make informed decisions on how to improve financial access.

In 2009, the results from two microcredit impact studies in Hyderabad, India, and Manila, the Philippines were released to mixed responses (Banerjee, Duflo, Glennerster, and Kinnan 2010; Karlan and Zinman 2011). Some media declared microfinance a failure (Bennett 2009). Many in the microfinance community dismissed these randomized studies as too limited to be a true reflection of the entire sector . . .

The original promise of microcredit was to reduce poverty by fostering self-employment in low-income communities, an idea first promoted at mass scale in Bangladesh (Yunus 1999). But critics of Muhammad Yunus and the Bangladesh microcredit model argue that supporting larger businesses (small and medium enterprises or SMEs) may instead create more and better jobs for poor individuals (e.g., Karnani 2007, Dichter 2006). That’s only possible, however, if those larger enterprises employ poor workers in large numbers. We argue that that can’t be assumed.

Low-income households are often trapped in a "debt-cycle": They borrow to cover necessary expenses, repay the loan with their subsequent income, then borrow again because they have nothing remaining after repayment. Inconsistent income and seasonality, especially for farmers, makes borrowing attractive at the time of necessity.

When the Gates Foundation started a programme to expand global ‘financial services for the poor’ (FSP), many in the field, myself included, saw this as an important complement to the foundation’s work in health and education.1 The evidence is piling up that the world’s poor face the twin problems of low incomes and difficulty managing their incomes without bank accounts or insurance. Finance, in this view, allows people to invest in the future and – importantly – to marshal resources to meet needs today. Access to finance, then, is a key tool for improving the lives of the poor. The Gates Foundation’s impact on finance for the poor has been most strongly felt in re-balancing attention between credit and savings.

Commitment devices facilitate self-control by allowing the customer to set aside future money and prohibiting withdrawal from these funds for a set period spending ; this allows them to circumvent the temptation to spend money immediately.

Roughly half the adults in the world, about 2.5 billion people, have no bank account nor even access to a ―semi-formal‖ financial service like microcredit. But what if they did? Muhammad Yunus, the 2006 Nobel Peace Prize winner and founder of Bangladesh’s Grameen Bank, argues that this lack of financial access means that the poor, especially poor women, can’t obtain the tiny loans (known as microcredit) that they need to build their businesses and get on a path out of poverty. The idea has taken hold: in 2009 Grameen Bank served 8 million customers (the average loan balance was just $127). World-wide, microcredit advocates claim over 190 million customers.

Is credit a human right? Muhammad Yunus, the most visible leader of a global movement to provide microcredit to world's poor, says it should be. NYU's John Gershman and FAI's Jonathan Morduch disagree.

"Best practice" in microfinance holds that interest rates should be set at profit-making levels, based on the belief that even poor customers favor access to finance over low fees. Despite this core belief, little direct evidence exists on the price elasticity of credit demand in poor communities. We examine increases in the interest rate on microfinance loans in the slums of Dhaka, Bangladesh. Using unanticipated between-branch variation in prices, we estimate interest elasticities from -0.73 to -1.04, with our preferred estimate being at the upper end of this range. Interest income earned from most borrowers fell, but interest income earned from the largest customers increased, generating overall profitability at the branch level.

FAI Insights: The Financial Access Initiative's Jonathan Morduch explains the motivation for his most recent research report with Jonathan Conning on "Microfinance & Social Investment." This is part 1 of a two-part video series.

The notion of “credit as a human right” flows from the argument that if we are concerned with universal access to food, shelter, and health, then we must be committed to providing access to the tools that are most likely to deliver those basic elements of life. For the sake of argument (and there is, of course, argument), we will follow Article 25(1) of the Universal Declara- tion of Human Rights, adopted by the United Nations in December 1948, and begin with the idea that access to food, shelter, and health constitute basic human rights. Yunus can then be interpreted as saying: access to credit is so powerful in reducing poverty, that access to credit should be a right itself.

Impact evaluations try to measure the change in a participant’s life that occurred because of an intervention. The “intervention” could be a policy, a project, an insurance product, or a specific feature of a product. For instance, the intervention could relate to a particular product feature, such as the extent of coverage, a change of pricing structure, or variations in the distribution channel. . .

This paper puts a corporate finance lens on microfinance. Microfinance aims to democratize global financial markets through new contracts, organizations, and technology. We explain the roles that government agencies and socially-minded investors play in supporting the entry and expansion of private intermediaries in the sector, and we disentangle debates about competing social and commercial firm goals. We frame the analysis with theory that explains why microfinance institutions serving lower-income communities charge high interest rates, face high costs, monitor customers relatively intensively, and have limited ability to lever assets. The analysis blurs traditional dividing lines between non-profits and for-profits and places focus on the relationship between target market, ownership rights and access to external capital.

Emergencies can derail families and prevent them from getting ahead. This study describes the design, implementation, and results of a pilot emergency (“hand”) loan product in India. The product achieved its original intent, but the pilot encountered considerable institutional and execution challenges. The experience generated lessons for future product innovation.

Michael Clemens, Senior Fellow at the Center for Global Development (CGD) and visiting scholar at the Financial Access Initiative and at NYU-Wagner and the NYU Dept. of Economics (Spring 2011), talks about the findings from his research into the UN Millennium Villages.

We use experimental measures of time discounting and risk aversion for villagers in south India to highlight behavioral features of microcredit, a financial tool designed to reduce poverty and fix credit market imperfections. The evidence suggests that microcredit contracts may do more than reduce moral hazard and adverse selection by imposing new forms of discipline on borrowers. We find that, conditional on borrowing from any source, women with present-biased preferences are more likely than others to borrow through microcredit institutions. Another particular contribution of microcredit may thus be to provide helpful structure for borrowers seeking self-discipline.

Using three indicators of quality, the authors investigate whether microinsurance can help improve the quality of healthcare provided to poor patients. The three indicators are: structure (material and human resources available to patients at healthcare facilities), process (what steps are followed in giving care to patients) and outcome (the effects of the care on a patient’s health status). The find that health insurance status is not significantly associated with better quality care as measured by the three dimensions of quality.

We investigate whether microinsurers can help improve the quality of healthcare, and not just its price. We study Indian patients who had a caesarean section, appendectomy, hysterectomy, or abdominal hernia surgery. We compare indicators of facility’s infrastructure; doctor’s qualification and knowledge; process of care; and patient satisfaction. Two thirds of insured patients contacted the insurer about their choice of provider. They are directed towards facilities that are part of the insurer’s network, which have better infrastructure than non-network facilities. Being insured, however, is not significantly associated with receiving better-quality care, even when controlling for several patient and facility characteristics.

Can the poorest be reached with finance? "Ultra poor" members of society face a series of constraints and deprivations that distinguish them from the general poor. Limited social networks, chronic malnutrition, and reliance on patronage systems characterize a socioeconomic class that is hard to "bank."

It’s not surprising that saving is hard for many of us. We’re impatient, temptations are at hand, and savings devices are seldom ideal. By the same token, it would not be surprising to find that we have a hard time keeping money in the bank. But, puzzlingly, new studies give examples of people withdrawing funds less often than neoclassical economic theory suggests they should (e.g., relative to the simulations of optimal savings in Deaton 1991). And, paradoxically, it is often the same people who had trouble saving who also have trouble drawing down their savings. Some are so reluctant to dis-save that they willingly borrow at expensive interest rates to avoid touching their savings.

Can the poorest be reached with finance? If yes, there are two main routes. The first option is for institutions to extend existing products and services to even poorer customers. The other is to design independent approaches that target the particular challenges faced by the ultra poor.

Microfinance banks use group-based lending contracts to strengthen borrowers’ incentives for diligence, but the contracts are vulnerable to free-riding and collusion. We systematically unpack microfinance mechanisms through ten experimental games played in an experi- mental economics laboratory in urban Peru. Risk-taking broadly conforms to theoretical predictions, with dynamic incentives strongly reducing risk-taking even without group-based mechanisms. Group lending increases risk-taking, especially for risk-averse borrowers, but this is moderated when borrowers form their own groups. Group contracts benefit borrowers by creating implicit insurance against investment losses, but the costs are borne by other borrowers, espe- cially the most risk averse.

Sukhwinder Singh Arora, co-author of two books Small Customer, Big Market: Commercial Banks in Microfinance (with Malcolm Harper) and The Poor and their Money (with Stuart Rutherford) talks about how the lessons from Portfolios of the Poor help providers design better products.

Stuart Rutherford, co-author of Portfolios of the Poor, discusses three MFIs that have redesigned their products to more adequately meet the three fundamental challenges poor households face. These challenges are outlined in Part 3 of this video series: Identifying and Meeting the Financial Needs of the Poor.

Stuart Rutherford outlines the three major challenges Portfolios of the Poor authors continually observed among diarists: 1) extreme poverty is not only about being very poor, but about managing daily expenses with unpredictable earnings and unreliable jobs: 2) the hardships of limited earnings are compounded by emergencies to which the poor are so vulnerable, forcing already-poor households to patch together an adequate level of cash; and 3) low wages and frequent emergencies prevent households from assembling usefully large sums for bigger expenses, such as housing, marriages, and education, etc.

Co-author Stuart Rutherford identifies the key lessons from Portfolios of the Poor and highlights misconceptions about the financial practices of poor households that its research helped to correct. Rutherford also answers questions about the diverse and complex saving methods employed by Portfolio diarists.

Bob Christen, director of the Financial Services for the Poor Initiative at Bill & Melinda Gates Foundation, offers a thoughtful introduction to Portfolios of the Poor. Critical to the value of microfinance, he states, is the recognition and understanding of the nuances in the financial lives of the poor: broader financial inclusion can be achieved in ways that extend beyond loans for investment purposes. Portfolios revealed that what poor households need are better ways to manage and save their limited resources. Christen emphasizes that with this awareness, microfinance practioners can design a better generation of financial instruments for the poor, and identifies Portfolios of the Poor as the "guide" to achieve this goal.

Yaw Nyarko, Professor of Economics at New York University and Director of NYU Africa House, talks about the particulars of the research for Portfolios of the Poor and how it will influence the development of new research trends.

Answering surveys is usually voluntary, yet much of our knowledge about microfinance depends on the willingness of households and institutions to respond to survey questions. In this study, Financial Access Initiative Managing Director Jonathan Morduch and Jonathan Bauchet explore the implications of voluntary reporting on knowledge about the performance of microfinance institutions, specifically focusing on the MixMarket and Microcredit Summit Campaign databases. They show patterns of systematic biases in microfinance institutions’ choices about which survey to respond to and which specific indicators to report. These patterns in turn affect analyses of key questions on trade-offs between financial and social goals in microfinance. The results highlight the conditional nature of our knowledge and the value of supporting social reporting.

The Grameen Bank of Bangladesh is the best-known and most widely imitated microfinance pioneer. But Grameen found itself in trouble in the late 1990s as the quality of its loan portfolio began to decline sharply, and a devastating flood further eroded loan repayments. It responded by adopting a new model in 2001, dubbed Grameen II. Grameen II was designed to be more flexible than the original model: aligning repayment schedules with household income flow, meeting the demand for secure and reliable savings products, and acknowledging the varied needs of clients. These new features were a shift from beliefs underpinning the original Grameen model, which emphasized the need for loans over savings, expectations that loans would be used only for micro-entrepreneurial investment, and the necessity of a strict repayment regiment. The research in Portfolios of the Poor includes sets of financial diaries collected from Grameen clients both before and after these changes, from 1999-2005.

If you listen to the strongest pitches for microfinance, you would imagine that everyone offered microfinance would leap at the chance to be a customer. Yet this is not so. Evidence shows that it’s usual that under half of eligible households participate in microfinance. Moneylenders are still in business, and many individuals in develop- ing countries still rely primarily on family and friends to meet their needs for money. This is not necessarily a bad thing: informal sources of credit provide a useful way to finance profitable investments or respond to life events. But it shows that the demand for existing microfinance institutions and products can’t be taken for granted.

How do the world’s poorest households manage their financial lives on $1 and $2 a day? The authors of Portfolios of the Poor tracked the earning, borrowing, spending, and saving practices of 250 households in Bangladesh, India, and South Africa. The resulting “financial diaries” reflect a mixed-research methodology that is systematic in data collection, and simultaneously captures the complexity of people’s lives. This brief takes a closer look at the research samples from all three countries.

The financial diaries provide insight into the prices poor households paid for financial instruments, and the logic behind their financial decisions. Researchers revealed that surviving on small, irregular, and unpredictable earnings often generates financial behaviors that at first seem counter-intuitive-such as paying or borrowing to save. Through the financial diaries approach, (see the “Research Methodology” Briefing Note) researchers were forced to confront assumptions and take a fresh look at understanding the price of microfinance-paying close attention to what price means to poor households, the cost financial institutions assume in lending to the poor, and the universal tension between the impatience to meet financial demands today, and the desire to save for the future.

When it is difficult to save, those who manage to build up a lump sum are reluctant to draw down on it. In fact, they are often so loathe to touch their savings that they willingly borrow at expensive interest rates. While the phenomenon of borrowing while saving is puzzling from the standpoint of traditional economics, it’s a regular feature in the financial diaries described in Portfolios of the Poor: How the World’s Poor Live on $2 a Day. This brief describes simultaneous borrowing and saving, and provides evidence for an explanation rooted in the difficulty of rebuilding savings. This evidence leads to another seeming contradiction—why high interest rates on loans may in fact be a desirable attribute for some borrowers.

Portfolios of the Poor: How the World’s Poor Live on $2 a Day examines the basic question of how the world’s poorest households survive on such modest incomes. The authors report on yearlong "financial diaries" of villagers and slum dwellers in Bangladesh, India, and South Africa-surveys that track penny by penny how households manage their money (see Research Methodologies Briefing Note). The stories of these families are often surprising and sometimes inspiring. Most poor households do not live hand to mouth, spending what they earn in a desperate bid to keep afloat. Instead, they rely upon an array of complex tools, and lead active financial lives because they are poor, not in spite of it. They create “portfolios” that leverage both informal networks and formal institutions to address their immediate and long-term needs.

This brief offers insight into the ways poor households manage risks. Based on the financial diaries research outlined in Portfolios of the Poor: How the World’s Poor Live on $2 a Day (see the "Research Methodologies" Briefing Note), this brief describes the formal and informal risk management tools used by poor households in Bangladesh, India and South Africa, and examines how these tools can be improved to help the poor mitigate risk and plan for the future.

The Portfolios of the Poor financial diaries in Bangladesh span 1999-2005. As well as giving a unique insight into the challenges faced by poor households, they show how the households interact with the uniquely saturated and rapidly growing microfinance industry in the country. Unlike many studies of microfinance that feature poor Bangladeshi households, these financial diaries depict the entire financial picture, showing how they use microfinance alongside the many informal financing mechanisms and the few formal services available to the poor.

Portfolios of the Poor offers new thinking about how the world’s poorest communities manage their financial lives. To uncover these intimate details, researchers designed a study in which they interviewed poor households twice a month over the course of a year, and recorded the details of how they lived their financial lives. These “financial diaries” encompass data from nearly 250 households in Bangladesh, India, and South Africa, and reflect a mixed-research methodology that is systematic in data collection while simultaneously captures the complexity of people’s lives.

Randomized experiments are increasingly popular ways to evaluate the impacts of development interventions. They provide hope that we can overcome important biases common to nearly all statistical evaluations. When done well, randomized control trials (RCTs) can provide clear, transparent, and credible evidence in complicated contexts, and it’s not surprising that they dominate clinical research in medicine.

Attempts to broaden financial access in poor communities usually take one of two directions. The first is providing credit to small- scale microenterprises, an idea pioneered by Bangladesh’s Grameen Bank. The second involves fostering long-term saving for education, housing, or other worthy goals. But low-income families usually have a more fundamental financial need, one that families often pay dearly for: basic, reliable ways to manage cash flow.

We describe important trade-offs that microfinance practitioners, donors, and regulators navigate. Drawing evidence from large, global surveys of microfinance institutions, we find a basic tension between meeting social goals and maximizing financial performance. For example, non-profit microfinance institutions make far smaller loans on average and serve more women as a fraction of customers than do commercialized microfinance banks, but their costs per dollar lent are also much higher. Potential trade-offs therefore arise when selecting contracting mechanisms, level of commercialization, rigor of regulation, and the extent of competition. Meaningful interventions in microfinance will require making deliberate choices – and thus embracing and weighing tradeoffs carefully.

Expanding access to financial services holds the promise to help reduce poverty and spur economic development. But, as a practical matter, commercial banks have faced challenges expanding access to poor and low-income households in developing economies, and nonprofits have had limited reach. We review recent innovations that are improving the quantity and quality of financial access. They are taking possibilities well beyond early models centered on providing “microcredit” for small business investment. We focus on new credit mechanisms and devices that help households manage cash flows, save, and cope with risk. Our eye is on contract designs, product innovations, regulatory policy, and ultimately economic and social impacts. We relate the innovations and empirical evidence to theoretical ideas, drawing links in particular to new work in behavioral economics and to randomized evaluation methods.

Microcredit is commonly credited with reducing poverty, empowering women, and delivering other important impacts, particularly to extremely poor house- holds. Rhetoric, however, has outpaced evidence. Empirical studies are scarce, and existing ones have been influential despite a lack of thorough scrutiny. In this paper, David Roodman and FAI managing director Jonathan Morduch attempt to replicate the two most-noted studies on the impact of microcredit, both based on survey data from Bangladesh collected in the 1990s. Pitt and Khandker (PK, 1998) find that microcredit raises household consumption, especially when lent to women. Khandker (2005) concurs and goes further to say that microcredit has more of an impact on the extremely poor than on the moderately poor. Morduch (1998) finds no evidence for impact on consumption levels, but does find that microcredit. decreases the volatility of consumption. This paper shows that the evidence for impact is weak in all of these studies. But, significantly, it doesn’t find that microcredit causes harm, and it doesn’t prove that the impacts commonly attributed to microcredit—like reducing poverty and empowering women—do not exist. Rather, this paper shows that it’s hard to draw much from these data—and that better answers will need to come from other data sets using other methods.

For microfinance institutions, particularly those aiming to take deposits, an advantage of regulation is that it allows semi-formal institutions to evolve more fully into banks. But complying with regulation and supervision can be costly, creating potential trade-offs. World Bank researchers Robert Cull and Asli Demirgüç-Kunt and FAI managing director Jonathan Morduch examined the balance between the benefits and costs of regulatory supervision, with a focus on institutions’ profitability and outreach to small-scale borrowers and women. The authors analyzed data on 245 of the world’s largest microfinance institutions, with newly-constructed data on their prudential supervision. Regression analysis showed that supervision does not have a significant impact on profitability: microfinance institutions subjected to more rigorous and regular super- vision are not less profitable compared to others. However, this type of supervision is associated with larger average loan sizes and less lending to women, suggesting that it does have a significant impact on outreach.

Regulation allows microfinance institutions to evolve more fully into banks, particularly for institutions aiming to take deposits. But there are potential trade-offs. Complying with regulation and supervision can be costly, and we examine implications for the institutions’ profitability and their outreach to small-scale borrowers and women. The tests draw on a new database that combines high-quality financial data on 245 of the world’s largest microfinance institutions with newly-constructed data on their prudential supervision. OLS regressions show that supervision is negatively associated with profitability. Controlling for the non-random assignment of supervision via treatment effects and instrumental variables regressions, we find that supervision is associated with substantially larger average loan sizes and less lending to women than in OLS regressions, though it is not significantly associated with profitability. The pattern is consistent with the notion that profit-oriented microfinance institutions absorb the cost of supervision by curtailing outreach to market segments that tend to be more costly per dollar lent.

Microfinance institutions have proved the possibility of providing reliable banking services to poor customers. Their second aim is to do so in a commercially-viable way. We analyze the tensions and opportunities of microfinance as it embraces the market, drawing on a data set that includes 346 of the world’s leading microfinance institutions and covers nearly 18 million active borrowers. The data show remarkable successes in maintaining high rates of loan repayment, but the data also suggest that profit- maximizing investors would have limited interest in most of the institutions that are focusing on the poorest customers and women. Those institutions, as a group, charge their customers the highest fees in the sample but also face particularly high transactions costs, in part due to small transactions sizes. Innovations to overcome well-known problems of asymmetric information in financial markets were a triumph, but further innovation is needed to overcome the challenges of high costs.

In some countries it can take years to get a new telephone line installed. In 1990, there were just 10 telephone lines installed for every 1000 people in the Philippines. In Kenya, the ratio was 7 per thousand. In India, 6 per thousand. Compare that with the United Kingdom with 441 lines per thousand in 1990, or the United States with 545. For decades, public sector telephone companies in developing economies seldom had incentives or budgets to rapidly expand land line networks, and the private sector has had even less motivation to serve the costly-to-reach.

Why do so many poor households lack access to finance? Are the unbanked creditworthy? Largely not interested in borrowing? The answers are at the heart of ongoing debates around the deepening of financial systems We examine household-level data from 1438 households in six provinces in Indonesia. All households, whether or not they were presently borrowing, were assessed by bank professionals to judge creditworthiness. About 40 percent of poor households were judged creditworthy, but only 14 percent had recently borrowed. Possessing collateral was a minor determinant of creditworthiness. Despite depictions of widespread pent-up demand for loans, about half of creditworthy poor households report being averse to taking on debt. Loans for small business were desired, but respondents often highlight broader household needs, including paying for school fees, medical treatment, and home repair.

“Smart subsidy” might seem like a contradiction in terms to many microfinance experts. Worries about the dangers of excessive subsidization have driven microfinance conversations since the movement first gained steam in the 1980s. From then on, the goal of serving the poor has been twinned with the goal of long-term financial self-sufficiency on the part of micro banks: aiming for profitability became part of what it means to practice good microfinance.

Two observations are essential to understanding the market structure of most low-income economies. First, many markets do not exist and, of those that do, many work imperfectly. Second and more optimistically, a wealth of behavioral and institutional responses often emerge to fill in the holes left by market failures. . .